Traditionally, wealthy families served as limited partners in private equity firms, which in turn backed portfolio companies. But over the last several years, family offices have begun hiring private equity professionals so they can invest in portfolio companies directly.
Not only do family offices gain more control over their investments, but they also skip the management fees previously paid to PE firms. Direct investing is expected to continue. “Family offices are staffing up their capabilities to invest directly,” says Paul Carbone, managing partner, Pritzker Group. “There is evidence to suggest that this is where a number of family offices are headed.”
Family offices are expected to continue investing directly. Private equity investors confide they have noticed more competition from family offices. The data backs up the trend. In 2014, 77 percent of respondents polled by McNally Capital said they preferred direct deals over going through private equity funds, up from 59 percent in 2010. And when polled in 2014, 84 percent of family offices said they planned to make a direct investment in a private company within 24 months.
Investing directly appeals to both buyers and sellers. Sellers are more likely to get a long-term partner with industry expertise, given that most family offices invest in sectors where they generated their original wealth. Family offices are more inclined to take legacy issues to heart, which often makes sellers feel more comfortable with a sale, especially if they are not exiting the company fully. Family offices increasingly like to invest directly because they have the industry expertise to do so and they don’t want to lock up their money in a blind pool and pay the typical 2 percent management and 20 percent performance fees charged by traditional private equity firms. Additionally, the returns are typically better in private companies than they are in the public market.
“A number of families are disenchanted with the traditional PE structure and want patient capital to build long-term value,” Carbone says. “They are also are comfortable with building companies on their own as many have built their wealth through company ownership so they don’t need a private equity firm to invest for them.”
Here are four families that are making direct investments:
When professionals in the industry reflect on the family office direct investing model, the Pritzker Group is at the forefront. However, the Pritzker Group does not like to be categorized as a family office. The firm feels the term is too broad and that it includes family offices that look nothing like the Pritzker Group. The firm prefers to be thought of as an investment company, and why shouldn’t it be? The Chicago firm boasts a venture capital investment business, an asset management business and a private capital business, along with 21 investment and operating professionals.
“The Pritzker family was at the forefront of the family investment trend when they built this business,” says Carbone. “I think you will see more and more families following suit.” The Pritzker Group has been investing family money directly into companies for 14 years. Carbone runs the firm’s private equity arm and he acknowledges that the firm actually operates like a private equity firm, but without the “bad stuff.”
Pritzker’s private equity arm typically acquires middle-market companies with enterprise values of between $100 million and $500 million, focusing on manufactured products, services and health care investments. Each of its deal teams has an investment professional and an operating partner.
The firm’s investments have included PLZ Aeroscience Corp. and Technimark, an Asheboro, North Carolina-based provider of custom rigid plastic packaging and components. Brad Wellington, CEO of Technimark, says PLZ had many options when it was looking for a partner in 2014, but thought that a traditional private equity wasn’t the right fit because PLZ was looking to finance a global expansion that would require a long-term outlook.
“We purposefully pursued this partnership to build the business long-term and support Technimark’s worldwide growth, and we felt our interests aligned with those of the Pritzker Group,” says Wellington. Under Pritzker Group’s ownership, Technimark has financed the expansion of the company’s German and Chinese facilities, opened a new Mexican facility and launched a new U.S. distribution and manufacturing plant, as well as a new innovation center.
In December, Technimark announced the acquisition of CI Medical to accelerate growth in the medical injection molding market. The company is expecting to combine CI Medical’s blue chip customer base and manufacturing capabilities with Technimark’s global footprint and financial resources to expand delivery of the company’s medical products.
In many ways, Pritzker sounds like a sector-specific private equity firm, but there are differences. “We are not compelled to deploy capital. Our capital is permanent. We can be patient and disciplined in our investing. We have three sector teams and we are happy to do a few deals a year or zero deals, depending on the marketplace. We also don’t have to worry about fundraising, which has become a full-time job for many private equity firms. We can spend our time focused on finding and building great companies,” says Carbone.
The Pritzker Group is led by Tony and J.B. Pritzker, who are very active in the firm. The Pritzker family is best known for creating the Hyatt hotel chain and the Marmon Group, a conglomerate of manufacturing and industrial services, which was sold to Warren Buffett’s Berkshire Hathaway Inc. (NYSE: BRK.A) for $4.5 billion in 2007. “Having them is like having a wonderful tool in our toolkit which we can bring to the table. They are smart guys and they will sit down with a company to talk with them about how we can build a company together. They are skilled and are a tremendous asset to our team and our companies,” says Carbone.
Still, despite the success, the Pritzker Group faces the challenges many firms do in today’s frothy market – competing against private equity firms and strategic acquirers. “This is a massive marketplace. Family offices aren’t replacing private equity, because private equity has a proven ability to create value. PE firms will remain the majority of the marketplace. As a result, competition will remain high for great assets, and nothing says that’s going to change for now. We are dealing with today’s market dynamics the same as everyone else, but we have different ways to compete and win,” says Carbone.
After Eric Becker’s 21-year-old daughter Cara died from complications of leukemia in 2012, the man who had co-founded Sterling Partners nearly 30 years earlier felt a profound change. Continuing to work at Sterling for a couple of years, Becker recalls, “I just didn’t feel the same energy that I had before, and I decided to retire.” He immersed himself in philanthropy, working the Karma for Cara Foundation, which his daughter had founded shortly before her death. Through the foundation, Becker bestows micro-grants to kids leading service projects. “I started to feel the energy coming back when I was working with kids. I was ready to go back to work, but I wanted to do things a little differently,” says Becker.
Becker started looking closely at what he liked about private equity and what he didn’t. The challenges of managing a larger fund included shorter hold periods and the constant fundraising. With those challenges in mind, he founded Caretta Partners, which invests Becker’s capital as well as capital on behalf of his friends and family, including Sterling Partners co-founders. “We have more flexibility. We can partner with founders and own fewer companies for a longer period of time. I liked the idea of really partnering,” says Becker.
When Becker reviews his investment career, he admits that some of his partnerships were amazing others were less so. But with the hopes of investing in just three to five companies in as many years, Becker says he has an opportunity to partner with companies he’s really passionate about. “Think chocolate and peanut butter; just a great combination,” says Becker.
Becker’s investment thesis is simple: the company must matter. “The company doesn’t have to be curing cancer, but the customers need to be passionate about the service,” says Becker. “Businesses have to be customer-centric, where the customers are at the center of everything.”
Becker also plans to take a long-term view on deals, with the ability to hold companies for as long as he pleases. Caretta will focus on health care, education, business services and companies involved in healthy living. The growth firm will take minority or majority positions.
Lastly, Becker wants to be sure he is focusing on companies that are within a two-hour plane ride from Chicago and Baltimore, where Becker spends most of his time. He wants to be active with portfolio companies without having to spend all of his time on planes.
Caretta’s family office model is already resonating with certain types of companies and people. “If the owners want to stay on or care about their legacy, they are interested in what Caretta is offering,” says Becker. “There’s stability to what we offer and a genuine caring about the leadership team. I didn’t really know what it would be like to do this, but the model is validated already. There are more deals to look at than I have capacity for.”
Becker says the Chicago firm’s deal pipeline is fairly full and he is fielding calls directly from the website daily in addition to sourcing deals from traditional sources, such as bankers and personal relationships. Caretta is also open to doing deals with fundless sponsors. “Fundless sponsors are an evolution in the industry that’s more understood now. They are opening the doors to deals for a lot of family offices,” says Becker. Caretta expects to have its first deal completed in early 2016.
Grand Crossing Capital Partners
In November 2015, Grand Crossing Capital Partners LP, a self-described “family-backed private equity firm” acquired a majority stake in Everglades Marine Holdings LLC, an offshore fishing boat company founded in 1997 by Boston Whaler executive Robert Dougherty. While Dougherty has retired as CEO, he will remain an investor in the company. The remainder of the Everglades team will stay in place and be led by Tom Flocco, executive chairman and interim CEO.
“We were searching for a partner to help us grow our business over the longer term,” Brian Bohunicky, chief financial officer of Everglades. “With their focus on unique consumer businesses and ability to hold investments for longer periods of time without mandates or timelines, Grand Crossing was the ideal partner for our business.”
The Everglades deal represents a typical transaction for Grand Crossing. The firm is funded by the family behind the Wilton Brands, a company founded in 1929 best known for decorating cakes. In 2007, Wilton Industries merged with EK Success, Dimensions Holdings LLC and K&Company, creating Wilton Brands, a large, diversified company in the craft industry owned by PE firm TowerBrook Capital Partners.
Grand Crossing has a team of five and invests primarily on behalf of the Wilton family, but will also take money from other families to complete a deal if it makes sense. Like many other family offices, Grand Crossing likes the flexibility of the family office model. “We have a longer hold cycle. For example, we know we will own the boat company through a recession,” says Brian Jacobsen, a managing partner with the firm.
“That would preclude many private equity firms from buying this company because you wouldn’t want to have to sell a boat company during a recession. But given our flexibility we were able to buy this company with much less competition.”
The longer time horizon is appealing to Grand Crossing and Jacobsen, who focused on retail investing as a partner at TowerBrook Capital Partners. “You can take your time to build the company without having to show growth right away. You have time to look at a company and say, ‘How can we build this brand and create value?’ We have that luxury with our arrangement.”
Grand Crossing invests between $5 million and $25 million of growth capital in control and minority stakes. The firm requires that portfolio companies be profitable and generate between $2 million and $10 million of Ebitda.
Everglades is Grand Crossing’s third investment. In 2014, the investment firm backed Kona Deep Corp., a bottled water company. Also in 2014, Grand Crossing joined Dallimore & Co. in making a minority investment in Victor Alfaro, the designer of ready-to-wear clothes, shoes and handbags who was well-known in the 1990s and has been making a comeback since 2013. Today, Alfaro’s lines are sold at Barneys New York, Net-a-Porter, Lane Crawford and the Room at Hudson’s Bay.
Howard Romanow is a good example of why family offices are able to compete for deals directly. Formerly of FDG Associates, Romanow now serves as COO and CFO of Island Management LLC, a Darien, Connecticut-based firm that invests in private companies on behalf of an unnamed family that made its wealth in consumer products. Romanow likes that now he no longer has “to worry about where the capital comes from.”
“More family offices want to go direct, but until recently many family offices didn’t really understand that they could hire the right professionals to invest on their behalf,” says Romanow. “When they realized they were paying all these fees, and there were professional resources to hire, they started building up their direct investing capabilities.” Romanow says the trend will increase, as the private equity industry matures, and junior partners look beyond traditional firms to further their careers.
The family behind Island Management looks to invest beyond the public markets, to operate companies and to benefit from diversification. “If something bad happens in Europe, it impacts the public markets. But if something bad happens in Europe, the private markets don’t necessarily react. There’s less correlation between geopolitical events and the private markets, and there is great potential for better returns,” says Romanow. “The family wanted to go direct because it doesn’t believe in the private equity philosophy. Private equity firms have to sell their winners to create returns for their investors and keep their losers. It’s the opposite of what our people wanted to do. If there is a company that is returning appropriately they want to keep it in the portfolio.”
Since 2014, Island has been looking for North American companies to buy and has closed one unnamed deal. “We are really more about partnership and the sellers knowing us, and that takes time,” says Romanow. “We are truly there to work with management and for the long haul. We are not thinking about how we get out in three years.”
For more, see Romanow's video interview with Mergers & Acquisitions.